If only JPMorgan had been privy to those titillating emails from the Bear Stearns guys packaging the residential mortgage backed securities (RMBS) – the emails calling the bombs they were preparing to unload on investors a “sack of shit,” or “a shit breather,” and urging colleagues to “close this dog.” JPMorgan might not have been so willing to step up to the plate at the beckoning of the New York Fed and acquire Bear Stearns as it teetered toward bankruptcy in March of 2008.

But packaging toxic mortgage backed securities and internally calling them disparaging names while failing to share that view with investors is becoming very old news on Wall Street. What is shocking news, even to veterans on Wall Street, is that Bear Stearns is alleged, by both the Securities and Exchange Commission and the New York State Attorney General, Eric Schneiderman, to have engaged in an extensive multi-year, pre-meditated plan to steal tens of millions of dollars that belonged to trusts set up for investors.

Even on Wall Street, outright theft used to mean something. But in the SEC complaint and settlement announced last Friday and the lawsuit filed by the New York State Attorney General on October 1 of this year, the individuals who participated in this theft and fraud are not named; only the Bear Stearns firms, which now carry a JPMorgan moniker, were named as defendants.

The SEC press release expresses this grand larceny as casually as though one were reading about an adolescent shop-lifting a candy bar at the corner deli:

“ J.P. Morgan also is charged for Bear Stearns’ failure to disclose its practice of obtaining and keeping cash settlements from mortgage loan originators on problem loans that Bear Stearns had sold into RMBS trusts. The proceeds from this bulk settlement practice were at least $137.8 million.”

Let’s put this in context: at the time this alleged crime took place, Bear Stearns was the fifth largest investment bank on Wall Street; it had assets of $395 billion; it was trusted by the SEC to act as a fiduciary over billions of dollars of client funds. And it was wantonly stealing money from investors’ trust accounts? And now JPMorgan owns this firm and its former employees?

As bad as all this sounds, the details are even worse: according to the SEC and the New York State Attorney General’s lawsuit, the firm’s lawyers were fully aware this theft was taking place.

Bear Stearns had extended wholesale lines of financing to its mortgage originators and was deeply in bed with them. It needed to keep even the sleaziest of them in business in order to keep its pipeline of mortgage securitizations flowing. This is how Schneiderman details the fraud in his complaint:

“Although loan originators were contractually required to buy back defective loans at an agreed-upon repurchase price, Defendants routinely permitted them to avoid this obligation by extending cheaper or otherwise more appealing alternatives. Specifically, Defendants offered substantial concessions to originators in order to preserve Defendants’ relationships with them and to ensure the continued flow of loans.

“For example, ‘in lieu of repurchasing the defective loans,’ originators were permitted by Defendants to confidentially settle EPD [early payment defaults, meaning monthly payments on the mortgage were missed within the first 90 days of the mortgage] and other claims by making cash payments that were a fraction of the contractual repurchase price. Defendants’ other concessions included agreements to cancel or waive entire claims against originators, and the creation of ‘reserve programs’ under which Defendants used funds collected from these originators towards future loan purchases.

“According to an internal presentation, during the period May 2006 to April 2007 alone, Bear Stearns resolved $1.9 billion worth of claims against sellers relating solely to EPDs. As a further accommodation to originators, Defendants also agreed to extend the EPD period so that already-securitized loans that had defaulted during the designated EPD period, and then started paying again, could remain in the securitization. This allowance was made despite Defendants’ recognition that an EPD is a strong indicator not only of a borrower’s inability to repay but also of fraud in the origination. Notably, Defendants’ extension of the EPD period applied only to securitized loans; extensions of the EPD period for loans in Defendants’ own inventory were expressly forbidden.

“Defendants kept settlement amounts for themselves rather than depositing the settlements into the relevant RMBS trusts, and failed to disclose that they were recovering and pocketing money from originators for settled EPD claims on loans that remained in their RMBS Trusts. Defendants also failed to further investigate whether any of the settled claims based on EPD, which could be a sign of fraud at origination, also constituted a securitization breach.”

The registrations for these RMBS trusts that were filed with the SEC assured investors that all rights, titles and interest on these mortgages were being transferred to the trust. How then to justify keeping tens of millions of settlement funds that belonged to the trusts?

If feels like Schneiderman is attempting to make the lawyers that were involved sound good. He has this to say in his complaint:

“Defendants’ own lawyers advised Defendants that EPD loans that were subject to settlements had to be reviewed for representation and warranty breaches and that Defendants could no longer keep for themselves the substantial monetary recoveries obtained on their EPD and other claims relating to securitized loans.”

But then there is that phrase “could no longer keep” the substantial sums. Exactly how long had the firm been pocketing the money and why did it take the lawyers so long to tell it to stop?

The SEC’s complaint, which was released and settled last Friday, calls the practice at Bear Stearns “bulk settlements.” It says the practice started in 2004 and lasted through late 2007. It paints a far less sanguine portrait of the role of lawyers that were advising Bear Stearns:

“Sometime in early 2006, the bulk settlement practice came to the Global Head’s attention, who sought more information from EMC [a Bear Stearns subsidiary] regarding the amount of, and procedures related to, the bulk settlements on trust-owned loans.

“Deliberations about how to deal with the bulk settlements involving counsel and Bear executives continued for many months through the end of 2006 and into early 2007, during which time certain of the funds were held in a separate account. By the end of February 2007, Bear decided that the practice would continue, that certain funds collected to date would be taken into income for first quarter 2007, and that future settlement funds would be allocated pursuant to a procedure that was yet to be devised, and which eventually became known as the ‘Settlement Waterfall.’ ”

New York State Attorney General, Eric Schneiderman

In that last sentence above, we now learn that Bear Stearns, according to the SEC, was stealing money from trusts and reporting it as income on its own balance sheet, thus defrauding its own shareholders of an honest accounting of its finances.

It is noteworthy that the New York State Attorney General does not fashion his complaint as lawyers aiding and abetting a fraud while the SEC paints a very different portrait of the role of lawyers. It is also noteworthy that neither regulator names the law firm(s) or participants that were involved.

If the U.S. justice system has reached the point where grand larceny on Wall Street is to be treated as a minor offense; is to be settled out of court without naming the participants, potentially leaving them still employed on Wall Street; potentially leaving them still giving legal advice to Wall Street – the next collapse cannot be far off, because no one, on or off Wall Street, will trust this system.